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Wednesday, January 25, 2017

My Investment Return for 2016

My December account statements finally came in and like I’ve done each year for some time, I’ve calculated my return for the year. Because of the new CRM2 rules, my account statements give my annual return, but it’s done separately for each account. I think of my portfolio as a whole that just happens to be spread across multiple accounts.

It was an above-average year. My internal rate of return (IRR) that takes into account cash flows was 13.65%. As a benchmark, I use Vanguard ETFs in the same asset allocation as my portfolio and compute the IRR with the same cash flows. Because I actually own Vanguard ETFs, my return doesn’t differ much from this benchmark. The only exception from indexing in my family portfolio was a small block of Berkshire Hathaway stock that my wife held for years, but sold in October. I use ETF VTV as a benchmark for Berkshire. My portfolio’s benchmark return was 13.62%. This is a hair below my actual return, so Berkshire outperformed VTV somewhat.

If my portfolio had started the year at exactly my target asset allocation and I never touched or added or took out any money, my return would have been 13.39%. This is below my benchmark return, which means that I got lucky with the timing of my cash flows; I tended to add money when my stocks were a little down. There was no skill at all in this because I add new money with fixed rules – no discretion on my part.

If I use the benchmark index returns that Vanguard provides for each of its ETFs, the tracking error of my portfolio works out to 0.03%. For some reason, this is lower than my portfolio’s blended MER of 0.08%. I assume this is some combination of luck and possibly revenue from Vanguard lending shares to short sellers.

One of my ETFs, VXUS, has foreign withholding taxes. Non-U.S. countries retain a withholding tax on stock dividends before the rest of the dividends go to Vanguard in the U.S. Currently, this tax is a 0.20% annual drag on VXUS returns. Because VXUS makes up 25% of my portfolio, foreign withholding taxes are a 0.05% additional drag on my portfolio’s returns. By holding my ETFs in RRSPs, TFSAs, and non-registered accounts strategically, I have no other drag due to foreign withholding taxes.

Other drags on my portfolio’s returns are trading commissions and spreads. In 2016, this added up to about 0.03%. The new CRM2 rules made it easy for me to find the total commissions I paid. Spread costs took more work. This cost is half the average bid-ask spread times the total number of shares traded. For infrequent traders of very liquid ETFs, this doesn’t amount to much.

So, what’s the point of all these comparisons if the differences are so small? The point is to make sure they’re small. If my portfolio has a leak, I want to know about it.

Here’s my cumulative real return history (subtracting out inflation) on a log chart:

You’ll notice that I had a spectacularly good 1999. That was the result of a wild bet on a single stock that grew to be a very large percentage of my net worth. I was very lucky. You may also notice that my returns didn’t look very good from 2000 to about 2010. This is roughly the period where I picked stocks. All I succeeded in doing was to give back some of my 1999 gains. Since 2010, my portfolio has been mostly indexed, which is why there is little difference between my returns and the benchmark.

Over the entire period, my average compound return has been 8.65% above inflation. It feels good to know that every dollar I’ve had invested the entire time has grown over six-fold in purchasing power. Going forward, I hope to average about 4% (less costs) above inflation.

I outperformed my benchmark by a compound average of 3.09% per year. But if we exclude 1999, I actually lost to the benchmark by 0.95% per year. I was lucky, and after that I wasn’t much of a stock picker. Particularly painful was a decision to sell a sizeable block of Apple stock at a split-adjusted price of $1.39. It now trades at about $120. I’m very content with my choice to index my portfolio.

It’s not necessary to go into the detail that I do when analyzing your annual returns. However, completely ignoring them is a mistake. Few investors know their annual returns. CRM2 will help some, but I’m willing to bet that if you ask someone about their returns, they’re likely to talk about their account that performed best.

Comparing your return to a benchmark may not tell you much in any given year, but there’s one pattern to watch for: if you trail an appropriate benchmark fairly consistently by about 2% per year, you may be invested in closet index funds. These are funds that pretend to be active and trying to outperform, but are actually just invested in a mix of stocks or bonds that closely match an index.

If you’re trying to get above-average returns, you should know whether it’s working or not. Otherwise, you’re just fooling yourself.

My portfolio is split roughly 50/50 between public and private equity, the above return is for public equity holdings only; private equity tends to be valued only at offering and upon exit, thus a true total return won't be known until such time.

For various reasons I don't compare my portfolio to any benchmark besides that of my own personal required rate of return.

"Total" because the "return is for public equity holdings only", or about 50% of my investable assets.

My long-term returns cannot yet be truly accounted because of the public/private split. It might be another 3-5 years for a true total return.

As well, over the years 100% of my money has never been 100% invested long-term in public equities. I have employed different "investing" systems, such as churning penny stocks ('90's) and precious metals ('10's), real estate, opportunistic businesses, and private equity in tandem with traditional stock market holdings.

A guesstimate for my 20-year total return might be 20%/yr. (I make 8%/yr just by holding my government job "investment"!)

And no, it doesn't really bother me that I don't know the exact number.

Hello Michael, Canadian Couch Potato recommends using both the modified-dietz method (using a spreadsheet on PWL Capital's website) as well as a money-weighted calculator. Can you please share your method for calculating your personal rate of return?

@Chrissy: I calculate my IRR, and calculate a benchmark IRR with the same cash flows as I used during the year, and compare the two. A while ago I wrote a thorough piece explaining the various approaches, including the one used by PWL Capital:

Wow, thanks for your quick reply Michael. I've read your linked article and will bookmark it for future reference as I'm still rather new to DIY investing and learning as I go. Thanks for sharing your knowledge and thoughtful opinions on money and investing.